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World Economic and Financial Surveys

Regional Economic Outlook: Europe

Fostering Sustainability

May 2010

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A weak and uneven recovery is underway in Europe. Macroeconomic policies still support the upswing and extraordinary measures are underway to address the sovereign crisis. Now policymakers face the difficult balancing act between continuing their support for the economy and establishing a credible path to policy normalization. Priorities are large medium-term fiscal consolidations and, in the financial area, a shift from systemic support to interventions in individual financial institutions. Structural weaknesses also need to be addressed, including the revamping of financial sector regulation and supervision, improvements in the functioning of products and labor markets, and filling gaps in the euro area’s fiscal governance. For emerging Europe, policies that facilitate a reorientation of the sources of growth toward the export sector and attract healthy capital inflows are key conditions to restart income convergence.

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Contents

1. Outlook: Getting the Exit Right
  Recovery in Low Gear
  Normalizing Policies
  From Exit to Restructuring
 
2. Managing Capital Flows
  Emerging Europe’s Diverging Policy Challenges
  Europe Was Different
  The Motivation for Precrisis Inflows
  Policy Implications
  Conclusions
 
References
 
Boxes
1. IMF-Supported Programs and External Adjustment
2. Toward a New European Financial System
3. Current Account Imbalances in the Southern Euro Area
4. Prudential Measures to Stem the Tide of Capital Inflows in Emerging Europe
5. Which Prudential Tool Is Best at Managing the Financial Stability Risks of Capital Inflows? Answers from Model Simulations
6. Russia’s Capital Flows: Experience and Challenges
7. Financial Reform: An Opportunity for the New Member States
 
Tables
1. European Countries: Real GDP Growth and CPI Inflation, 2006–10
2. European Countries: External and Fiscal Balances, 2006–10
3. Uses of Capital Inflows, 2000–07
 
Figures
1. The Great Contraction: What Drives Cross-Country Differences
2. Euro Area: Contribution to Growth, 2006–09
3. Asset Prices Compared with Pre-Lehman Levels
4. Euro Area: Bond, Equity, and Money Markets
5. Key Drivers of the Expected Recovery, 2009–10
6. Selected European Countries: Key Short-Term Indicators
7. Euro Area: Gross Investment Ratio of Nonfinancial Corporations, March 2000–September 2009
8. Europe: Credit Indicators
9. Selected European Economies: Gross Household Savings Ratio, March 2000–September 2009
10. Selected European Countries and the United States: Unemployment, February 1999–January 2010
11. Selected European Countries: Headline and Core Inflation, January 2006–February 2009
12. Selected European Economies: Monetary Aggregates and Multipliers, June 2006–February 2010
13. European Economies: Cross-Country Standard Deviation of GDP Growth and Current Account Balance, 2000–14
14. European Economies: Stabilizing Public Debts
15. The Volume and Composition of Capital Inflows, 2001–08: Emerging Europe Was Different
16. Emerging European Economies: Macroeconomic Performance by Region, 2001–09
17. Composition of Capital Inflows in Central, Eastern, and Southeastern Economies (CESE), 2003:Q1–2009:Q3
18. Structural Reforms and Capital Inflows
19. External Privatization Receipts and FDI
20. Countries Received Capital Inflows in Excess of Convergence Reasons
21. Capital Inflows and Nominal Exchange Rate Flexibility
22. Real Lending Rates and Nominal Exchange Rate Appreciation of the Currency
23. Capital Flows and Real Domestic Demand
24. Rising Share of FDI into the Financial Sector Was Associated with Higher Cross-Border Loans to Banks and Corporates and Credit Growth
25. Capital Inflows and Competitiveness
26. The Wage-Cost Gap Between Sectors and Labor Market Policies
27. Capital Inflows Did Not Seem to Respond to Capital Scarcity
28. Banking Indicators Displayed Systemic Stability
29. Return on Assets, 2007
30. Currency Mismatch and Capital Inflows, 2007
31. Capital Inflows and Restrictions on Capital Flows, 1995–2007
32. Credit Default Swap Spreads, January 2008–March 2010
 
Appendix Tables
1. Capital Inflows Panel Regression
2. Policy Responses to Capital Inflows, 1993–2007